Thursday, March 29, 2012

The story of Europe has been the story of two steps forward and one step back. Here are the two steps forward/

Since the eurozone crisis, the ECB has taken steps with its LTRO programs to stabilize the banking and financial system. Moreover, I wrote that Mario Draghi, on behalf of the eurocrats, outlined the Grand Plan as a way to fix the long-term problems within the eurozone. The Grand Plan consisted of two steps, which sound like pages taken from the Maggie Thatcher playbook:

Austerity in the form of "good austerity", defined as lower taxes and less government spending; and

Structural reform, which is the European version of the China taking steps to smash the iron rice bowl, which translates to union busting and going after all of the entrenched interests of the old with their lifetime jobs and gold-plated pensions at the expense of the young jobless.

Spain is likely, in our view, to be pushed into a troika (EC, ECB, IMF) programme of some kind during 2012, possibly by losing access to market funding on affordable terms, but more likely by the ECB making a programme for the Spanish sovereign a condition for continued willingness to fund the Spanish banks, which are currently the main buyers of newly issued Spanish sovereign debt. The existing and likely near future EFSF/ESM and IMF financial facilities are unlikely to be sufficient to both fund the Spanish sovereign fully and leave enough financial ammunition in reserve to deal with possible sovereign financial emergencies in Italy or in the ‘soft-core’ of the euro area. The Spanish sovereign would therefore likely continue to fund itself at least partly in the markets even if it comes under a programme. To ensure market access by the Spanish sovereign, the same combination of cheap ECB funding for periphery banks and financial repression of periphery banks by their national authorities that has been effective in lowering sovereign yields since the first LTRO is likely to be required.

Buiter did concede that the government is taking steps to implement structural reforms:

It did use this period to pass several important pieces of structural reform legislation. Among these were labour market reforms aimed at reducing severance pay in the long-term contract sector (while introducing or raising it in the flexible contract sector); reforms aimed at reducing the scope and incidence of industry-wide collective bargaining and replacing it with something closer to firm-level or establishment-level contracting; the imposition of an additional €50bn provisioning requirement on the banks; and laws aimed at strengthening central government control over the finances of the lower-tier authorities (autonomous regions and municipalities).

...though he was uncertain as to their implementation:

Passing legislation and implementing it are not the same thing, however, as we know from the Greek experience. In addition, both structural reform and a medium-term programme of fiscal austerity based on a politically acceptable formula for fiscal burden sharing look necessary to restore Spain to fiscal sustainability. The new government’s decision to wait 100 days to introduce its first budget, in the pursuit of electoral gain, did little to boost Spain’s standing in global markets.

Spain is a too-big-to-fail country within the eurozone. Market angst is starting to rise over the willingness of the Spanish government and the Spanish people to bear the pain of austerity.

Will Spain fall and bring down the eurozone in another crisis? I doubt it. This is the back-and-forth of the Theatre of Europe, but some form of Grand Plan 2.0 compromise will likely emerge. I agree with Gayle Allard at the IE Business School in Madrid who says to not count Spain out in a crisis:

[Allard] said Spain’s biggest problem is investors’ lack of faith in the population’s willingness to withstand austerity. “They don’t see the Spanish people in that way, they don’t understand how a country can put up with it,” she said.

“Having watched Spain through previous crisis, they are a pretty surprising country. They get behind things, hard things,” Allard said. “I don’t think this is ever going to look like Greece and that’s something the markets don’t understand.”

Italy does structural reform
Over in Italy, FT recently reported that Mario Monti clashed with the unions over structural reforms "that would give companies more flexibility to fire workers for economic reasons" and he is winning because of weakened opposition:

[W]ith the [labor union] CGIL considerably weaker than a decade ago and with the main political parties in no position to offer a coherent alternative to the present government, political commentators doubt Mr Monti’s technocrats risk being driven from office.

Opinion polls indicate strong public support for Mr Monti in general, although a majority of Italians opposes changing Article 18 which protects workers in the courts from wrongful dismissals for economic reasons. Under the proposed changes, employees would receive compensation but not reintegration back into their workplace.

Monti is also following the Grand Plan script of structural reforms which pit the young unemployed against their elders, who have secure jobs:

With nearly a third of young people unemployed, Mr Monti also wants to end Italy’s two-tier labour market that protects older workers on indefinite contracts but provides little or no security for mostly new hires on short-term contracts.

The politicians are indeed following through with painful structural reforms. In the meantime, there is doubt from the markets that they can implement them even if the legislation is passed. In a typical EU-style compromise, some of the legislation will get watered down, but I believe that the pendulum is swinging back and the momentum toward structural reform is inevitable.

For now, the message for investors is be prepared for some downside volatility out of Europe. But also know that it is likely a temporary hiccup out of which Grand Plan 2.0 will emerge.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Monday, March 26, 2012

Last week, I wrote that the character of the stock market had changed. The market had gone from a central bank liquidity driven rally, which favors hard assets and asset inflation plays, to a focus on the American consumer as a source of growth (see This bull depends on the US consumer).

To review, leadership had gone to Consumer Discretionary stocks, which was in a relative uptrend against the broad market:

...and Financials, which had broken its relative downtrend line and has now staged a relative breakout through resistance:

Europe mirrors the US
I reviewed the chart patterns of the European sectors on the weekend and (to my surprise) found a similar pattern. European Financials had broken out of a relative downtrend, but they weren't as strong as American Financials as they have not yet staged a relative breakout, but appear to be undergoing a sideways relative consolidation:

European consumer stocks are broken down as Consumer Goods and Consumer Services, which is not quite the same categorization that we find in the United States. Nevertheless, I was surprised to see that the European Consumer Goods sector has been in a long relative uptrend against the market and had staged a relative breakout and pullback after spending several months undergoing a sideways consolidation period:

The European Consumer Services sector was not as strong, but had nevertheless provided leadership in the latest rally.

Market bullish on US and Europe consumer, but worried about China
When I look around the world and listen to the market, the stock markets are telling me that first stage booster of central bank liquidity has dropped and and it's up to the second stage rocket, namely the American and European consumer, is on course to lift us past escape velocity. There is one drag to our rocket, however, and that's the prospect of a slowdown in China, as the weakness in commodity prices and commodity sensitive currencies are signaling those concerns.

Expect a rally, but define your risk tolerance
A bullish bet is therefore a bet on the health of the American and European consumer - and that is indeed a fragile foundation for a rally. Nevertheless, unless I am convinced otherwise the stock market remains in an uptrend. The chart below shows the weekly NYSE Summation Index, which is a breadth indicator, which I have overlaid a slow stochastic, an overbought/oversold indicator. If past history is any guide, stocks are tactically oversold and likely to rally in the next couple of weeks.

If you believe that we are in an uptrend, then the current period is likely to resemble the circled December 2010 correction and consolidation period in the middle of the QE2 rally. If you believe that the market is likely to correct further, another analog (circled) might correspond to the weakness seen in June 2010.

In both cases, the oversold readings of the stochastic point to a tactical rally in stocks for the next couple of weeks. In all cases, it would be wise to stay long, but carefully define your risk tolerance with the appropriate stop loss orders. In the meantime, watch the news flow and in particular closely watch how the market reacts to news coming out of China.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Another market analyst made the point to me succintly about the lagging performance of commodities and commodity related stocks. The Aussie Dollar is underperforming the Canadian Dollar. Australia is more levered to China (and more weighted to base metals) while Canada is more exposed to the United States. If CADUSD is outperforming AUDUSD, then it's a sign that the market believes that there is more near term economic upside in the US compared to China.

Bullish tripwires
I have made the point that depending on the American consumer to fuel this equity rally is a risky bet. If this rally is have any real legs, then we need to see a broader based rally around the world. Right now, the weak link is the Chinese outlook. As a pre-condition, commodity prices ideally should start to recover more and begin to take a leadership position in the next few months in order for this bull to get a second wind.

Here are what I am watching for. First, commodity sensitive currencies like the Aussie Dollar need to, not only hold support, but to show some strength and rally through resistance at 108.60.

Similarly, the Canadian Dollar, which has held up better than the AUDUSD exchange rate, needs to rally through resistance at 101.60.

Finally, I am watching the Hang Seng Index, which rallied up to 21,800 but couldn't overcome the overhead resistance at that level. I view the more established Hong Kong market as an important barometer of Chinese policies towards the teetering property sector.

The Hang Seng is now approaching a minor technical support level. Should it decisively break support, that would be a sign that the bears have won a round in the bull-bear tug of war.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Monday, March 19, 2012

I suppose I should be happy. I was correctly bullish on stocks and the Dow has decisively broken through the 13K mark, the NASDAQ Composite is through 3,000 and the SPX has rallied above 1,400. Positive momentum was confirmed by overseas markets such as the European markets, which also staged upside breakouts through technical resistance. It turns out I was right, but for the wrong reasons.

Surprising leadership
What's been surprising to me is the nature of the leadership in this rally. This rally was underpinned by global central bank liquidity. The BoJ, BoE, ECB and the Fed have all undertaken some form of quantitative easing and the flood of liquidity usually buoys asset inflationary expectations, which leads to rallies in commodities, cyclicals and high beta growth groups such as emerging markets. This time, the leadership in equities has not been in those sectors, but something more unusual.

Consider where the leadership has come from in this rally. First of all, the usual defensive sectors such as Utilities and Consumer Staples are lagging (not shown). Next, we see a turnaround in Financials, which is consistent with the narrow miss from a global financial meltdown from the eurozone crisis. The chart below shows the relative performance of Financials against the market. The sector has turned around and staged an upside relative breakout, which is not surprising under the circumstances.

Next, we see surprising leadership from Consumer Discretionary, which is providing leadership as it is in a well-defined relative uptrend against the market.

In another surprise, we see a similar pattern with the Homebuilders.

There is also apparent leadership from Technology stocks, but the relative performance of Technology is mainly from a single stock: Apple.

Consider the relative performance of the equal weighted NASDAQ 100, which largely eliminates the price performance of AAPL. Views in this context, the relative performance of the Technology sector has actually stalled and it's been rolling over in the last month or so.

What is surprising is that cyclical stocks are not showing the expected leadership in this rally, though they are participating in the upturn.

Neither are traditional high-beta groups like emerging market stocks.

Commodity prices, as represented by the CRB Index, are turning up - but the bull move has been anemic given the tsunami of central bank liquidity that's hit the markets in the past few months.

The consumer ascendant?
What's going on? What is the market saying?

I believe that the message of the market is growth depends upon the American consumer. We are seeing an unusual stock market leadership pattern and bond prices tanking (which I discussed in further detail here in my last post). What the market is saying, in effect, that the US economy is hitting escape velocity and growth, which is based on the US consumer, is starting to look self-sustaining.

Wow! The American Consumer is now the New Growth stock theme! Even The Economist is talking about a recovery - so it must be true.

True, the consumer is eating out more (see analysis here), which is a boost for Consumer Discretionary stocks. Housing seems to be stabilizing and showing uncertain signs of recovery, but there are indications that we are seeing a low quality housing recovery as the consumer seems to be trading down to mobile homes.

I was quite comfortable getting bullish based on a global central bank liquidity theme. As they say, "Don't fight the Fed." I am less comfortable with pinning my bullish outlook on the American consumer and robust US economy growth. With the ECRI sticking with its recession call, which is admittedly a fragile stick-your-neck-out call, this puts the rally on a less firm and riskier ground.

In fact, star bond manager Jeffrey Grundlach said in an interview that he expects bond yields to rise further and it would choke off any economic recovery:

Veteran bond investor Jeffrey Gundlach, who runs $30 billion at DoubleLine Capital in Los Angeles, said yields could rise further but the 10-year yield would have trouble holding much above 3 percent because that level would hurt the economy.

"Now that Treasuries have broken out to higher yields after six months of mind-numbingly low volatility, it is logical to expect the move to higher rates to last more than one week," Gundlach said. "The way things look today I think a move toward 3.25 percent would weaken the economy noticeably."

To be sure, high frequency economic releases have been coming in mainly above expectations, but insiders have been selling heavily, which is bearish. Looking globally, it's not clear at all that this recovery is self-sustaining at all. To put the burden of the stock market rally on the US economy and consumer is indeed a heavy weight to bear.

The CRIC Cycle: Crisis, Response, Improvement, Complacency
Does this mean that investors should sell all their stocks and run for the hills? Not yet. Barry Ritholz wrote about what he termed the CRIC Cycle.

1. Response: When any crisis reaches a panic stage, authorities will typically react (and overreact) creating an overwhelming response to the crisis. This usually includes lots of cash and some immediate legislative relief.

2. Improvement: This response throw enough money at the problem that symptoms are temporarily relieved. The improvement is not structural, but rather, is driven by a sugar rush of excess liquidity. It feels good but it is not economically nutritious.

4. Repeat: With few of the structural problems fixed, the excess liquidity eventually flows to the same sources of the original crisis, setting the stage for the next crisis .

He went to say that he believed the US is in the late stages of this cycle:

Bringing us up to date, the US appears to be deep in the Complacency stage. Things have noticeably improved, but the structural problems underneath remain.

In Europe, we seem to be late in the Response phase, awaiting the early Improvement part of the cycle to kick in.

I agree with his assessment. The chart below of a ten year history of the ratio of SPY (stocks) to TLT (long Treasury bonds) as a measure of the risk-on/risk-off tells me that this risk-on rally has further upside potential as risk appetites are only normalizing.

If the past is prologue (and that cannot be relied upon), we could see a scenario something like this (Note: Wild ass guessing to follow). Markets kiss 13,000, pullback and consolidate. But they are not overbought sufficiently for anything more serious than a modest retracement, and so they continue higher for several months, until the % of stocks over 200 day MA is near 90% (they are at 75% today). That takes us somewhere between March and June. The next sell off begins, lopping 25% or so off of the SPX. The Federal Reserve waits until after the November election to introduce QE3, and the cycle starts anew.

My inner investor remain bullish, but he is a nervous bull. My inner trader tells me not to worry. These issues with the American economy and consumer are 3Q or 4Q problems. So let's party on, but keep an eye out for the exit.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Friday, March 16, 2012

In my last post, I wrote about former Fed staffer Vincent Reinhart's in Barron's musing about Bernanke's lack of political capital to engage in quantitative easing after June, so another round of QE is likely in the cards at or before the June meeting. I had suggested that investors should carefully scrutinize the FOMC statement for hints of further easing, or statements about other "unconventional means" such as sterilized QE.

The Committee expects moderate economic growth over coming quarters and consequently anticipates that the unemployment rate will decline gradually toward levels that the Committee judges to be consistent with its dual mandate.

...but left the door open for further easing because they did not see inflation to be a threat:

The recent increase in oil and gasoline prices will push up inflation temporarily, but the Committee anticipates that subsequently inflation will run at or below the rate that it judges most consistent with its dual mandate.

There was no mention of any discussion about other measures, such as sterilized QE. In effect, the Fed is in a wait and see mode, but signaled that it is prepared to stimulate should signs of weakness appear. However, it did also indicate that tightening is not around the corner.

Bond yields go on a tear
So what was the market reaction? In the wake of the FOMC announcement, Treasury yields spiked. Not only did 10-year yields rally through a critical technical resistance level, it breached a downtrend that began in April 2011.

In effect, the bond market is saying that an economic recovery appears to be self sustaining. Under these circumstances, bond yields should be rising as faster growth would raise inflationary expectations.

In the wake of the sudden rise in Treasury yields, the blogosphere has been full of stories about how the Chinese have either stopped or lessened their purchase of Treasury securities because of their falling current account surplus and need to import commodities, such as oil (see examples here and here). While that might a plausible longer term explanation, Chinese demand didn't change on a dime on Tuesday after the FOMC meeting. Market expectations did.

Here is the risk for the Bernanke Fed. The Fed has traditionally used the short end of the yield curve to inject or withdraw liquidity from the market. Now the Bernanke has began to use "unconventional" measures to intervene in the long end of the curve. There has been a lot of discussion and hand wringing at the Fed about why housing didn't respond well to these stimulus measures. Indeed, there was discussion about how the next round of QE would be targeted at the MBS market instead of just the Treasury market.

Mortgage rates are benchmarked off Treasury yields. As Treasury yields rise, which they are doing now, mortgage rates should respond. In effect, this backup in Treasury yields has to potential to kill the fragile housing recovery (if there is one) and Bernanke is at risk of losing control of the bond market as an instrument of Fed policy.

If the markets are tightening when the Fed doesn't want to tighten, how will it respond?

In the past, the Federal Reserve has used interviews and leaks after significant announcements to "clarify" its statements. Watch for further statements in the days to come to see the Fed's reaction to the backup in bond yields. On the other hand, if there is no comment within the next couple of weeks, then I would interpret the silence as a signal that the central bank is comfortable with a rise in bond yields.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest. None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

There are others who subscribe to my view of an easy Bernanke Fed. In a Barron's article (subscription required), former Fed insider Vincent Reinhart, of Morgan Stanley (and husband of Carmen Reinhart), believes that Bernanke may not have the political capital to undergo another QE cycle in 2H2012, so any accommodation needs to be brought forward:

But a long-time observer of Fed policy—from the inside and the outside—thinks another round of quantitative easing, or other measures, is likely later this year. Vincent Reinhart, Morgan Stanley's chief U.S. economist, formerly was director of the Fed's Division of Monetary Affairs and served as the FOMC's secretary and economist, so he has seen things from both sides.

In his latest report, Reinhart writes there is a 75% probability the Fed will take some "unconventional action by June" because of the "political calendar." The central bank is supposed to be above the political fray, but this former Fed insider thinks Ben Bernanke & Co. will want to keep a lower profile in the second half of the election campaign season.

Secondly, the economics also will justify a move, he continues. (I may be naïve but I still find it jarring to list economics after politics in determining Fed decisions, but I'm not an ex-insider.) Economic slack (read "unemployment") persists and inflation remains below the Fed's medium-term projections, Reinhart notes.

Moreover, he notes the Fed sees risks the economy could slow. "Here, too, at Morgan Stanley, we share the view that the fillip to economic growth associated with a restock of inventories is fading and that real [gross domestic product] growth will slow notably in current quarter. Anxiety-inducing headlines that the economy is losing steam will be conducive to Fed action."

If Vincent Reinhart is correct, then Bernanke may not have the political capital to undertake another round of QE. That's why we had the "leak" about the Fed considering "sterilized bond buying" as a way of appeasing the hawks inside and outside the Fed.

As they have before in the aftermath of financial crises or wars, governments and central banks are increasingly resorting to a form of “taxation” that helps liquidate the huge overhang of public and private debt and eases the burden of servicing that debt.

Such policies, known as financial repression, usually involve a strong connection between the government, the central bank and the financial sector. In the U.S., as in Europe, at present, this means consistent negative real interest rates (yielding less than the rate of inflation) that are equivalent to a tax on bondholders and, more generally, savers.

In the past, other measures also included directed lending to the government by captive domestic entities (such as pension funds or banks), explicit or implicit caps on interest rates, regulation of cross-border capital movements, and (generally) a tighter coordination between governments and banks, either explicitly through public ownership of some institutions or through heavy “moral suasion” by officials.

If I am right about this theme about the Fed getting to give the patient another shot of adrenaline, then it would be regarded as short-term bullish for risky assets (though it may not do much longer term).

That`s why my inner trader is carefully scrutinizing the FOMC statement to watch for any change in language.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned

Monday, March 12, 2012

I wrote back on February 22, 2012 to expect a period of consolidation and correction, but the intermediate trend remained up. Last week, we saw the stock markets decline for 1% or more on Tuesday. Since then, equities have been flat. There is no doubt that correction is here.

Which analog? March 2011 or Dec 2010?
At the same time, a number of bears have suggested the current market is similar to the conditions of March/April 2011 when the market began to top out and ultimately fell, citing conditions such as insider selling.

I beg to differ. While insider activity is a concern, the flood of central bank liquidity continues. This Bernanke Fed has shown itself to be highly activist. Chairman Bernanke has indicated that he is willing to tolerate a higher inflation rate under the current weak conditions. The leak about sterilized QE shows the lengths Bernanke is willing to go in order to appease the hawks and get what he wants, i.e. further stimulus, at the same time.

Moreover, I have written before that funds flow remains positive for equities and the risk-on trade. Institutions are underweight and re-allocating funds into equities. Once the allocation begins, it's hard to stop. Individuals were underweight and are now roughly market weight as their fund flows are just getting started. Todd Salamone of Schaeffer's Research put it this way:

[A] survey by the National Association of Active Investment Managers (NAAIM) revealed that the average manager was only 57% net long last week, down significantly from the 74% the prior week. For perspective, optimistic extremes during the past five years have been at 85% or higher net long, which we last saw in early 2011.

In short, I believe the best analog for this market is the brief correction we saw in December 2010, which was in the middle of the QE2 rally in equities.

The periods look the same. I have circled the December 2010 period in blue and the March/April 2011 in green. The stock market had seen a golden cross shortly before the December 2010 correction, just as we did now. The rally was just getting started as a result of the tsunami of central bank liquidity, just as we are now.

The market declined to test the 50-day moving average and rallied. By contrast, the market corrected harder in March 2011 and fell through the 50-day moving average. (At the very least, these episodes show the value of the 50-day MA trailing stop as a risk control device.)

We can see a similar pattern by looking northward to the more resource-heavy and cyclically oriented TSX Composite in Canada. The market was in an uptrend and corrected in December 2010 and the uptrend was ultimately broken in March 2011. Today, the market remains in an uptrend that began in October 2011 and corrected but the current uptrend remains intact. During the QE2 rally, the market experienced a golden cross in September 2010. Today, the market is about to see a golden cross, indicating that the rally is just getting started.

Similarly, the relative performance of the Morgan Stanley Cyclicals Index against the market tells the same story. Cyclicals remain in a relative uptrend today. During the QE2 rally, the December 2010 correction was just a hiccup in the relative uptrend, which ended in March 2011 when the uptrend was violated.

In short, the internals are pointing to a brief correction just as we saw in December 2010. Monetary conditions are similar. Uptrends are intact, as measured by trend lines and 50-200 day trend following models.

Is this correction over?
My inner investor is convinced that he should stay long and ride out this short-term volatility. On the other hand, my inner trader wants to know if the current correction is over.

Not quite. The chart below shows the weekly Summation Index for NYSE stocks, a breadth indicator, to which I overlaid an overbought/oversold stochastic model. Here are a few observations. First, the fact that the Summation Index got to overbought levels suggested that the market was poised for a consolidation and corrective period. Now that we have entered that correction, which has been albeit mild, we need to see the stochastic move to oversold levels before calling the all-clear, just as we saw during the December 2010 episode.

In conclusion, my inner investor is staying long. My inner trader is expecting another week or two of correction and consolidation before the uptrend in stocks and other risky assets continues.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Declaring that the environment “has improved enormously” and there are “many signs of returning confidence in the euro,” Draghi yesterday turned the spotlight on “upside risks” to inflation, which is now forecast to remain above the ECB’s 2 percent limit this year. That suggests policy makers don’t plan to cut rates further or add to their 1 trillion euros ($1.32 trillion) of long-term loans to banks, economists said....

The Frankfurt-based ECB must “go back to normal, classical central bank policy,” he said.

Draghi's message to the politicians was, "We've done our part, it's time for you to do yours" as he hinted that not only would there be no further LTROs, but the next ECB step would be some form of tightening.

How much of that is to be believed?

The Theatre in Europe
I wrote about how Draghi revealed the Grand Plan in a WSJ interview, which consisted of:

"Good" government austerity, in the form of lower taxes and less spending; and

Structural reform, in the form of the elimination of the European social model.

For the that Grand Plan to work, you need a compliant central bank to print money so that the system doesn't seize up. So how much of what Draghi said is bluster and how much is real?

I interpret what Draghi said as being totally consistent with the message of: We will print more money if necessary, but on the condition that the politicians move forward with the Grand Plan's reforms. Otherwise, be prepared for tightening.

It seems to me that even the Germans are on board with the Grand Plan. Despite the German cultural aversion to money printing, notice that there wasn't a single complaint from either the Bundesbank or any of the German hardliners about LTRO, which has been documented to enormously expand the ECB balance sheet? Instead, we got a letter from Weidmann of the Bundesbank complaining about a technical point with LTRO, i.e. the quality of collateral.

Is this complaint about collateral quality just theatre? If so, then is Draghi's comment about going "back to normal, classical central bank policy" also part of that theatre?

I interpret all these statements as part of the "show" that's been going on in Europe as the elites proceed with the Grand Plan. The German complaint is part of the chorus of doubt that accompanies the main show and so is the ECB response, but they are not likely to be significant. No doubt, the ECB has the power to derail everything should any government step out of line, but my guess is that everyone pretty much knows the score. If needed, don't be surprised if the ECB stepped up with further LTRO or LTRO-like programs. Recall that I wrote that analysis reveals that the European banking systems may need up to four LTROs in order to fund their liquidity needs to 2013.

I recognize that the ECB doesn't want the banks to get addicted to LTRO, but do you expect the Draghi to allow European banks to fail as long as the Grand Plan is proceeding smoothly?

Expect more drama, but also expect a happy ending as long as all the players know their lines.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Thursday, March 8, 2012

My inner investor tells me that what matters in the medium term is the American consumer behavior and much of that depends on the employment picture and how good they are feeling about themselves and the economy.

My inner trader tells me that, given the corrective market action we saw on Tuesday, Friday's NFP release is going to be a huge bellwether in determining short-term market direction.

Duelling models
Ahead of the NFP release, we have seen hugely disparate in either direction. TrimTabs is forecasting a subpar 149K new jobs, "based on an analysis of daily income tax deposits to the U.S. Treasury from all salaried U.S. employees". Gallup, which does a telephone poll of 18K respondents by telephone, put out a press release indicating that they expect the March unemployment rate to tick up significantly.

On the other hand, other forecasters like Deutsche Bank is looking for a big upside surprise to the NFP number. Ed Yardeni says the same thing by pointing to the the buoyant ISM surveys and the aggregated results of Regional Fed surveys of manufacturing activity.

...but the ADP report said that a lot of job growth they saw came from smaller businesses.

Analyzing the data
What do you do? Who do you believe?

Here is how I have analyzed the data. First, the Gallup data is not seasonally adjusted. A comparison of this February vs. February last year shows an improvement. As a quick and dirty on a seasonal adjustment, if you compare the sequential change last Jan to Feb was 0.4% and so was this year. So maybe even if Gallup is right, NFP doesn't come in that badly?

On the other hand, the Gallup poll sample is 18K respondents. The sample size of the Regional Fed survey that Yardeni depends on is probably lower, though they are businesses and not individuals.

The Gallup survey is a rolling survey, which tends to be a bit more accurate. However, Gallup forecasts the unemployment rate, which is a function of employment and labor force size (and labor participation rate). However, the market focuses on employment, not unemployment. So given all the seasonal adjustments (a wildcard), even if Gallup is right the number may not come out that badly.

Even though I am leaning slightly bullishly on the NFP release. Trying to guess the NFP headline number and the subsequent market reaction is like betting on the flip of a coin. At best, the NFP figure is extremely noisy. Even if you had an edge, which would be slight given the enormous error term, it would be like being the house at a casino where a high roller ambled up to a roulette table and put several billions dollars on red. Despite having a slight edge, you would be feeling extremely nervous.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest. None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

What is deeply troubling is that Brent crude should have reached fresh records in sterling (£79) and euros (€94) - with a knock-on effect on US petrol prices, mostly tracking Brent - even though the International Monetary Fund has sharply downgraded its world growth forecast to 3.25pc this year from 4pc in September, and even though International Energy Agency (IEA) has cut its oil use forecast for this year by 750,000 barrels per day (bpd).

Oil is not supposed to ratchet defiantly upwards in a downturn, which is what we have with the Euro zone facing a year of contraction in 2012, and much of the Latin bloc sliding into full depression. Japan‘s economy shrank in the fourth quarter.

The reason is Peak Oil, or Plateau Oil, where crude supply is not expanding to meet rising global demand because of rising emerging market affluence.

Asia’s emerging powers of Asia - the key force driving the commodity boom of the last decade - are in various stages of “soft-landings” after hitting the monetary brakes last year to check property bubbles and curb inflation. China’s manufacturing has been bouncing along near contraction levels through the winter. So what happens when it recovers?

The unpleasant fact we must all face is that the relentless supply crunch - call it `Peak Oil’ if you want, or `Plateau Oil’ - was briefly disguised during the Great Recession and is already back with a vengeance before the West has fully recovered.

The commodity markets are now selling off over China's new GDP growth of 7.5% as it shifts from export driven growth to internal consumption growth. I would argue that the move is commodity bullish (instead of bearish as interpreted by the market knee-jerk reaction) because resource intensity grows because of the shift to consumption, as shown by this analysis from the Council on Foreign Relations.

Indeed, the emerging market demand story has become so prominent that Big Picture Agriculture points out that Asian oil demand has already risen to exceed North American demand.

Not too late to buy energy stocks
It's such these kinds of positive fundamentals that makes me a long-term commodity and energy bull - and it's not too late to buy energy stocks. The chart below shows the price chart of Select SPDR Energy ETF, or XLE, going back to 2000.

I have also constructed a crude trading signal for energy stocks. Below the main XLE price chart, I show the relative performance of the more volatile Oil Services ETF (OIH) against the more stable XLE, which is more heavily weighted with integrated oils. Note that troughs in the OIH/XLE ratio have been good times to buy. Investors would have seen higher prices within a year after each of those buy signals. Moreover, if you had waited for the OIH/XLE ratio to rise by 0.25 to 0.30 after each of those buy signals and sold your position, you would have profited handsomely.

We just saw a buy signal for energy stocks last year. Based on the OIH/XLE ratio, it's not too late to buy and ride the energy stock bull.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest. None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

I got a fair amount of feedback and pushback on my last post (see Why I am still bullish). Most have pointed to contrarian sentiment indicators, such as the Rydex Bull/Bear ratio, showing that traders are excessively bullish on stocks.

The Do's and Don'ts of sentiment models
Let's go back to first principles on sentiment models. The basic assumption behind sentiment models is that if a certain group is in a crowded long position, then there is little or no buying power to push the market up further. I said in my last post that both individuals and institutions are in no way overweight equities relative to historical experience. Institutional fund flows into stocks have barely begun, which provides sustainable buying power. Individual investors have been selling out of equity mutual funds and funds flows barely turned positive. Are those signs for you to run for the hills?

Such conditions set up the possibility that we can experience a series of readings that show too many bulls in sentiment models, which are shown in red in the chart above, during a rally where the market advances steadily such as the QE2 stock market rally that began in late 2010. At the same time, technicians could see a series of "good overbought conditions" as the market grinds higher.

For traders, sentiment models can be notoriously fickle. Since the Dow first kissed the 13K level and pulled back, some measures of sentiment have seen bullishness drop significantly. In fact, the latest Bespoke survey, which is admittedly unscientific, shows more bears than bulls and we have seen similar levels of waning bullishness amongst the respondents of other surveys.

A case of bad breadth? Or just a "good" Apple?
Another knock against the bullish outlook are the negative divergences seen in the markets. The Dow Jones Transportation Average has lagged. But as Mark Hulbert pointed out, there has been disagreement among Dow Theorists about the significance of that divergence.

Other technical analysts have pointed to the poor relative performance of small cap stocks. It is said that when large caps lead the market, it is a sign of faltering leadership, i.e. the generals are leading but the troops aren't following.

Are small caps truly faltering, or is is just the case of a large cap rocketship - in this case Apple?

The chart below shows the relative performance of the small cap IWM against the large cap SPY. The relative performance of small caps against large caps broke down in late February by violating a relative uptrend that began in October (shown in green) and at the same time broke down against a relative support level (shown in blue). Now consider the relative performance of IWM against EWI, which represents an equal-weighted S+P 500 and largely neutralizes the effects of Apple's rally, shown on the bottom panel. Note that small caps remain in a relative uptrend against large caps. How much of the relative breakdown is due to the capitalization effect of Apple?

You can see the same effect more dramatically when we compare the relative performance of the NASDAQ Composite against the NASDAQ 100. Similarly, the small cap NASDAQ Composite broke down in late February against the mega-cap NASDAQ 100. However, the bottom panel shows that the NASDAQ Composite remains in a relative uptrend against the equal-weighted NASDAQ 100.

A correction is possible but not inevitable
So where does that leave us? If you are an investor, the intermediate term trend is still up (note that Warren Buffett recently expressed his bullishness). I would be inclined to stay long and ride out any short-term choppiness.

If you are a trader, you have to be prepared for a correction, which may or may not occur. In some ways a correction is overdue because stocks have been rising steadily this year without a single day where the market has fallen 1%. On the other hand, you also have to be prepared for the possibility that there is no correction and the market grinds upwards while undergoing a series of "good overbought conditions" until individual and institutions have fully loaded up on equities.

Even if a correction were to appear, it would likely be mild. The first support level for the S+P 500 would be the 50-day moving average, which is 3-4% below current levels. In this video, Jeffrey Hirsch, of the Stock Traders Almanac, believes that the market is likely to see a mild correction in the second half of March but would view that as a opportunity to deploy more cash. He then expects the markets to continue to rally until year-end.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Monday, March 5, 2012

As the stock market consolidates and the Dow flirts with the 13K level, there have been some calls for an intermediate term top. I remain bullish over the next few months for the following reasons:

The risk trade bull run remains intact

Positive funds flow are buoying the markets;

Panic levels are still elevated;

"Expert opinion, defined as the better market timers, are bullish;

The Bernanke Put and Draghi Put still lives; and

The China property bubble lives on for another day.

The risk-on trade is still "on"

If you were to view the stock market through the lens of the risk-on/risk-off trade, then the risk-on bull move remains intact. Consider this chart of the relative performance of SPY against IEF, which shows a short-term relative uptrend in the context of an intermediate term uptrend.

Positive funds flowsJosh Brown pointed to a Reuters article indicating that institutional equity funds flows are positive. He went to say that they are likely to continue:

In my experience, these types of raising and lowering equity exposure cycles take place at a glacial pace and they rarely turn or stop on a dime.

Scott Grannis wrote that individual investor equity funds flows are just starting to turn positive and there is a lot of room for them to go further into stocks:

...and out of bonds, whose flows are still positive:

Grannis' conclusion was:

Adding it all up, I would say that we are a long way from seeing over-priced equities. Let's wait to see many months or even a few years of inflows to equity funds before concluding that the guy on the street is too bullish.

Panic levels are still elevated
Also consider the readings of the Crash Confidence Index from the Yale School of Management. A low level indicates a high level of fear and a high level indicates a high level of complacency. While the ECB's LTRO program has largely taken the risks of a banking meltdown off the table, investors confidence remain low and fear levels are still elevated. I interpret these conditions as being contrarian bullish.

"Expert" opinion is bullishMark Hulbert reports that the best market timers are leaning bullish, while the worst market timers are leaning bearish.

As an example, I don't know where the Aden sisters are in Hulbert's ratings, but I have tremendous respect for them and they are bullish. I have followed them, off and on, since the late 1970's during the gold mania that took bullion up to its peak of $850 in 1980, which they correctly called. Unlike other gold bugs, they turned bearish on gold and turned bullish on equities in the intervening period. They correctly called the rebirth of the commodity bull about ten years ago.

The Bernanke and Draghi Puts still lives
Ben Bernanke, in his testimony to Congress last week, said in so many words that QE3 isn't a done deal and they are watching the data carefully.

In light of the somewhat different signals received recently from the labor market than from indicators of final demand and production, however, it will be especially important to evaluate incoming information to assess the underlying pace of economic recovery.

The markets sold off but the flip side of this coin is that they are ready to act should the economy weaken.

The dual objectives of price stability and maximum employment are generally complementary. Indeed, at present, with the unemployment rate elevated and the inflation outlook subdued, the Committee judges that sustaining a highly accommodative stance for monetary policy is consistent with promoting both objectives.

So does that mean that good economic news is good news for the markets but bad news isn't necessarily bad news?

As for the ECB, interbank lending in Europe is still seized up. This analysis shows that the European banking system needs another four LTROs to get through to 2013. Don't be surprised if the ECB announces further rounds of LTRO.

In short, the Bernanke and Draghi Puts will "put" a floor on the stock market for now.

The Chinese property bubble lives on another dayWalter Kurtz, writing at Pragmatic Capitalism, noted that the property market in Beijing and Shanghai are recovering. Such a development should forestall any immediate concerns about a crash in the Chinese property bubble as official actions have kicked the can down the road and delayed the day of reckoning yet once more.

The Shanghai Composite has responded with a rally as a result of these measures. As the chart below shows, the index has rallied through a downtrend line and it has not even approached the first Fibonacci retracement level, which would serve as a resistance level.

Bearish tripwires
To be sure, not every market forecast is correct. Here is some of what I am watching for to see whether the bears are wrestling control of this market away from the bulls. These are some important questions that need to be answered in order to determine the next major move in equities.

First and foremost, the big question is can the Dow can overcome the 13K mark?

Looking at foreign markets, can the Hang Seng overcome resistance after rallying to fill the gap depicted in the graph below?

What about Europe? The Euro STOXX 50 appears to be undergoing a sideways consolidation. Can it rally to overcome resistance?

The cyclically sensitive Australian Dollar is temporary stuck in a trading range. Will it break out to the upside, which is bullish, or to the downside, which is bearish?

Another important cyclical indicator is the relative performance of the Morgan Stanley Cyclical Index against the market. Cyclicals started 2012 on a tear, but they have begun to consolidate sideways on a relative basis. Can the relative support level hold?

Lastly, technicians have been sounding words of caution because the Dow Transports have been lagging and have not confirmed the advance of the Industrials Average. Mark Hulbert writes that there is some disagreement about prominent Dow Theorists about the significance of this divergence:

Frustratingly, not all Dow Theorists agree on an answer. In fact, two of the three monitored by the Hulbert Financial Digest — Jack Schannep of TheDowtheory.com and Richard Moroney of Dow Theory Forecasts — think the appropriate point of comparison is not last summer but late October. And because, near the end of December, the Dow averages rose above their late-October highs, both Schannep and Moroney believe that the Dow Theory is solidly in the bullish camp — notwithstanding where the Dow transports might be relative to their July high.

In contrast, Richard Russell, editor of Dow Theory Letters, says he’s worried about the Dow transports’ weakness and, in part for that reason, is largely out of the stock market.

The chart below shows the relative performance of the Dow Jones Transports against the Dow Industrials. If relative performance were to fall below the 38% Fibonacci retracement support level, it would mean that the bears have taken control of the market.

In conclusion, I believe that equities are consolidating their gains but remain in an intermediate bull phase. During this consolidation period, doubts will appear about the legitimacy of the bull leg, as they are now. My view is that the next major move is up, but I am watching and open to the possibility that I am wrong and a correction can run deeper than I expect.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Saturday, March 3, 2012

Forget about the alligators. Let's talk about draining the swamp. There is a way out of this quagmire for Europe. Ken Rogoff, in an interview with Der Spiegel, believes that political integration (or a "United States of Europe") is closer than anyone expects:

SPIEGEL: Do you honestly believe that the countries in the euro zone can bring themselves to hand over that much more power to Brussels?

Rogoff: The terrible thing is that few countries in Europe seem genuinely prepared for that. Those politicians who know what is needed keep quiet, fearing opposition from the voters. But the pressure of this crisis will create a momentum whose scope and impact we cannot yet imagine. At the end of the day, the United States of Europe may well come about a lot quicker than many would have thought.

SPIEGEL: With all respect to your optimism, the Europeans are unlikely to play along with that. The popular opinion in most member states is that Europe has far too much power, not too little.

Rogoff: Europe is in an interim stage, quite similar to that in late 18th century America. The ratification of the United States constitution in 1788 was preceded by 12 years of a loose confederation, which sometimes worked but usually didn't. Europe is in a similar situation today. States are like people, it is difficult to sustain a stable half-marriage; either you go for it or you forget it.

Much of the latest eurozone crisis stems from the fact that there was economic integration without political integration. Rogoff believes that the European elite within the Community will take this latest crisis to push for greater integration.

This is all part of the Grand Plan that I wrote about before. Mario Draghi, in an interview with the WSJ, said that the steps include:

Austerity, defined as lower government expenditures and lower taxes; followed by

Structural reform, defined as the elimination of the European social model.

In the meantime, the ECB stand ready to provide the necessary tonic (such as LTRO) to smooth the transition as long as the eurozone was moving in the right direction. Greater European integration, as per Rogoff, would be one of those steps.

The optimist in me says that if the Europeans manage to pull this off, it will result in a new Renaissance for the EU and the global economy. The World Bank warned this week that China may be at risk of a middle-income trap as the supply cheap labor, which was the primary source of competitive advantage, diminishes. Were Chinese growth were to slow and the slack were to be taken up by a surge in Europe in the next decade, it would be a source of welcome global rebalancing.

Key risks
The caveat, of course, is that everything has to go right. For example, Bruce Krasting pointed out that some hospitals in the PIGS countries have not paid their drug bills for up to three years and the outstanding bills amount to €12-15 billion. Stories like these suggest that there are liabilities out there beyond sovereign debt as represented by the bond market that the market isn't very aware of. How much and can the Powers That Be skirt these potholes as they come up? I don't know.

The greatest political challenge to the Grand Plan of austerity, structural reform and political integration is the discontent on the Street. Consider this chart of European youth unemployment. Note how it is going up everywhere except for Germany.

We have a map showing how to get out of the swamp. Can the European elites steer the EU out? I am not sure, but not all is lost. Just remember how Thatcher's reforms revitalized Britain. Is the current situation on the Continent very much different from the UK in the early 1980's?

I remain cautiously optimistic longer term. Consider the judgment of the markets. If Europe is in such trouble, then why has the EURUSD exchange rate been rallying?

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

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Welcome to my blog Humble Student of the Markets. These are my observations and musings about the markets (mostly equities), hedge funds and investments in general.My experience has been a quantitative equity manager in US, Canada, EAFE and Emerging Markets and commentator on hedge funds and their returns patterns.

DISCLAIMERThis is not investment advice! I know nothing about you, your risk preferences, your portfolio or your investment horizon. I have no idea whether any of my opinions expressed are suitable for you.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this blog constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. I may hold or control long or short positions in the securities or instruments mentioned.